USD Continues to Remain Strong Against CAD as Crude Oil Prices Continue to Fall

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Canadian Dollar Sinks as Crude Oil Prices Swing, USD May Weaken

Canadian Dollar, Crude Oil, US Dollar, Monetary Policy, Fiscal Stimulus – Asia Pacific Market Open

  • Canadian Dollar sinks as crude oil swings, Wall Street closes lower
  • Investors weighed Fed easing against a delay in key fiscal stimulus
  • Futures hint upbeat mood next, US Dollar may see near-term losses

Canadian Dollar Sinks as Crude Oil Swings, US Dollar Mixed as Stocks Fall

The Canadian Dollar fell on Monday, responding negatively to intraday swings in sentiment-linked crude oil prices. CAD appeared to pay more attention to declines than gains in WTI as the Dow Jones and S&P 500 closed -3.04% and -2.93% to the downside in another volatile day on Wall Street. Investors weighed the implications of more aggressive Fed stimulus versus Congress being unable to pass a fiscal package.

Markets initially welcomed the Federal Reserve announcing unlimited quantitative easing . The central bank said that it will purchase bonds and mortgage-backed securities “in the amounts needed” to support a smooth functioning market. This is on top of already slashing rates to a 0.00 – 0.25% range and relaunching 2008 crisis-era tools to help boost liquidity in financial markets.

There is also much urgency in passing a fiscal package to accompany monetary policy given the limits of the latter prior to the coronavirus outbreak. A US$2 trillion relief bill was unable to gather enough votes in the Senate on Monday as lawmakers struggled to agree on the details of the measure. A delay in its passage may have been what erased gains that equities were able to pull off earlier in the Wall Street session.

The US Dollar had a mixed session, outperforming against the Canadian Dollar, Japanese Yen and British Pound. This is as UK Prime Minister Boris Johnson ordered the country’s citizens to stay home “except for essential reasons”. The Greenback continued to gain on some of its emerging market and ASEAN counterparts. Capital flight continues to pose a risk for markets in developing economies as the USD gains.

Tuesday’s Asia Pacific Trading Session – US Dollar, AUD/USD, NZD/USD, USD/CAD

A lack of key economic event risk places the focus for foreign exchange markets on sentiment during Tuesday’s Asia Pacific trading session. Futures tracking Wall Street are pointing cautiously higher, pointing to what may be a “risk-on” tilt to come. The haven-linked US Dollar is weakening with the growth-linked Australian Dollar attempting to progress higher.

US President Donald Trump mentioned that both Democrats and Republicans are “fairly close” on a stimulus bill. Democratic leader Nancy Pelosi is preparing a $2.5 trillion package. Signs of a further delay in passing a virus relief bill risks souring market mood. Otherwise the Greenback could see some weakness in the near term as AUD/USD and NZD/USD rise. USD/CAD could thus fall. The situation is highly fluid however.

Understanding the Correlation of Oil and Currency

There is a hidden string that ties currencies to crude oil. With the price actions in one venue, it forces a sympathetic or opposing reaction in the other. This correlation persists for many reasons, including resource distribution, the balance of trade (BOT), and market psychology. Also, there is crude oil’s significant contribution to inflationary and deflationary pressures that intensifies these interrelationships during strongly trending periods—both to the upside and to the downside.

Oil and the U.S. Dollar

Crude oil is quoted in U.S. dollars (USD). So, each uptick and downtick in the dollar or in the price of the commodity generates an immediate realignment between the greenback and numerous forex crosses. These movements are less correlated in nations without significant crude oil reserves, like Japan, and more correlated in nations that have significant reserves like Canada, Russia, and Brazil. 

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Key Takeaways

  • Oil and currencies are inherently related wherein price actions in one force a positive or negative reaction in the other in countries with significant reserves.
  • The USD has benefited from crude oil’s precipitous decline since the energy sector is a significant contributor to U.S. GDP.
  • Countries that depend heavily on crude exports experience more economic damage than those with more diverse resources.
  • Countries that buy crude oil and those that produce it exchange USD in a system called the petrodollar system.

Development of Oil Correlations

Many nations leveraged their crude oil reserves during the energy market’s historic rise between the mid-1990s and mid-2000s, borrowing heavily to build infrastructure, expand military operations, and initiate social programs. Those bills came due after the 2008 economic collapse, where some countries deleveraged while others doubled down, borrowing more heavily against reserves to restore trust and trajectory to their wounded economies.

These heavier debt loads helped keep growth rates high until global crude oil prices collapsed in 2020, dumping commodity-sensitive nations into recessionary environments.   Canada, Russia, Brazil, and other energy-rich countries struggled for a few years, adjusting to plummeting values in Canadian dollars (CAD), Russian rubles (RUB), and Brazilian reals (BRL), but showed signs of rebounding in 2020 and 2020. 

Selling pressure has spread into other commodity groups, raising significant fears of worldwide deflation. This has tightened the correlation between affected commodities, including crude oil and economic centers without significant commodity reserves like the Eurozone. Currencies in nations with significant mining reserves but sparse energy reserves, like the Australian dollar (AUD), have plummeted along with the currencies of oil-rich nations.

Trouble in the Eurozone

Plummeting crude oil prices set off a deflationary scare in the Eurozone after local consumer price indices turned negative at the end of 2020. Pressure built on the European Central Bank (ECB) in early 2020 to introduce a large-scale monetary stimulus program to stop the deflationary spiral and add inflation into the system. The first round of bond-buying in this European version of quantitative easing (QE) began the first week of March 2020. QE by the ECB continued until mid-2020. 

EUR/USD vs. Crude Oil

Many forex participants focus their full attention on the EUR/USD cross, the most popular and liquid currency market in the world. The currency pair topped out in March 2020, just three months before crude oil entered a mild decline that accelerated to the downside in the fourth quarter—at the same time crude broke down from the upper 80s to low 50s.     Euro selling pressure continued into March 2020, ending at the same time that the ECB initiated its monetary stimulus program.

Venezuela has the largest number of crude oil reserves, according to OPEC.

U.S. Dollar (USD) Impact

While the United States has moved up the ranks in worldwide petroleum production, the U.S. dollar has benefited from crude oil’s precipitous decline for several reasons. First, U.S. economic growth since the bear market has been unusually strong compared to its trading partners, keeping balance sheets intact. Second, while the energy sector significantly contributes to U.S. GDP, America’s great economic diversity reduces its reliance on that single industry.

USD vs. Crude Oil

Invesco DB U.S. Dollar Index Bullish Fund (UUP), a popular USD trading proxy, hit a multi-decade low at the height of the last bull market cycle in 2007 and turned sharply higher, hitting a three-year high when the bear market ended in 2009. Then, higher lows in 2020 and 2020 set the stage for a powerful 2020 uptrend that began just one month after crude oil peaked and entered its historic downtrend. 

Inverse lockstep behavior continued between instruments into 2020, when the USD continued its pullback. The top was simultaneous with the start of the ECB’s QE program, illustrating how monetary policy can overcome crude oil correlation, at least for significant time periods. The run-up into an anticipated FOMC rate hike cycle has contributed to this holding pattern as well.

Results of Over-Dependence

It makes sense that nations that are more dependent on crude oil exports have incurred greater economic damage than those with more diverse resources. Russia offers a perfect example, with energy representing over 65% of its total 2020 exports. 

The country fell into a steep recession in 2020, with GDP declining 4.6% year-over-year in the second quarter of 2020, intensified by Western sanctions tied to its Ukraine incursion. GDP for Q3 2020 fell 2.6% year-over-year, and then 2.7% for Q4 2020. Then, with the turnaround in crude oil prices, Russian GDP saw a marked turnaround. GPD growth turned positive in Q4 2020 and has remained so ever since.

Gazprom is Russia’s largest oil producing company.

Here are the countries with the highest crude oil exports based on barrels per day, according to the CIA’s World Factbook with data from 2020:

  • Saudi Arabia with 7.3 million
  • Russia with 5.1 million
  • Iraq with 3.3 million
  • The United Arab Emirates with 2.7 million
  • Canada with 2.7 million 

Economic diversity shows a greater impact on underlying currencies than absolute export numbers. Colombia ranks 19th, but crude oil represents 25% of total exports, pointing to high dependence illustrated in the collapse of the Colombia peso (COP) since the middle of 2020.   Meanwhile, that country’s economy has cooled off considerably after a torrid growth spurt.

The Ruble’s Collapse

Many Western forex platforms halted ruble trading in early 2020 due to liquidity issues and capital controls, encouraging traders to use the Norwegian krone (NOK) as a proxy market. USD/NOK shows a broad basing pattern between 2020 and 2020 at the same time that crude oil was bouncing between $75 and $115.     Crude oil’s downturn in the second quarter of 2020 matches a powerful uptrend that accelerated in the fourth quarter.

That rally continued into second-half 2020, with the currency pair hitting a new decade high. This points to continued stress on the Russian economy, even though crude oil has come off its deep lows. Still, the pair has soared along with crude oil. High volatility makes this a difficult market for long-term forex positions, but short-term traders can book excellent profits in this strongly-trending market.

USD/CAD struggles to advance beyond 1.3700 as WTI steadies above $30

The USD/CAD pair surged at the start of the week and touched its highest level since May 2020 at 1.3758 as plummeting crude oil prices weighed heavily on the commodity-sensitive CAD. With crude oil prices staging a technical rebound during the European trading hours, the pair pulled away from its tops but found support at 1.3570. As of writing, USD/CAD was trading near 1.3650, adding 1.7% on a daily basis.

WTI crashes, USD continues to weaken against its peers

After failing to reach an agreement on oil production cuts with Russia on Friday, Saudi Arabia slashed its export oil prices to start a global price war. With the initial reaction, the barrel of West Texas Intermediate fell to $27.30 before retracing a portion of its sharp fall. At the moment, the WTI is trading at $32.20, still down more than 20% on a daily basis.

Commenting on this development, “due to the drop in global oil demand, in combination with the existing and most likely even rising oversupply, oil prices will continue to trade lower, and for longer,” said ABN AMRO senior energy economist Hans van Cleef. “In line with our downward revisions of economic growth forecasts, global oil demand will only modestly recover during the second half of 2020.”

In the meantime, the US Dollar Index (DXY) extended its slide as markets hit the panic button and caused the 10-year US Treasury bond yield to fall to a fresh record low of 0.36%. With the DXY erasing nearly 1% and struggling to make a meaningful recovery, the pair’s upside remains limited for now.

There won’t be any macroeconomic data releases from the US or Canada on Monday and markets will remain focused on crude oil prices and Wall Street’s opening bell.

Technical levels to watch for

Overview
Today last price 32.24
Today Daily Change -9.57
Today Daily Change % -22.89
Today daily open 41.81
Trends
Daily SMA20 49.66
Daily SMA50 53.96
Daily SMA100 55.76
Daily SMA200 55.75
Levels
Previous Daily High 46.48
Previous Daily Low 41.22
Previous Weekly High 48.74
Previous Weekly Low 41.22
Previous Monthly High 54.69
Previous Monthly Low 43.95
Daily Fibonacci 38.2% 43.23
Daily Fibonacci 61.8% 44.47
Daily Pivot Point S1 39.86
Daily Pivot Point S2 37.9
Daily Pivot Point S3 34.59
Daily Pivot Point R1 45.12
Daily Pivot Point R2 48.43
Daily Pivot Point R3 50.39

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